5/19/2009 @ 2:00PM

A Medicare Explosion

Last week, the Social Security and Medicare Trustees released this year’s annual report on the economic health of its two programs. Unfortunately, both the Trustees and the financial press focused on the trivial and ignored what is really important.

The trivial concern is the status of the Social Security and Medicare trust funds. In fact, these are not really trust funds. They do not collect or disperse money. They hold no real assets. They perform an accounting function (keeping track of the inflow of dedicated revenues and the outflow of funds to the programs they support), which occasionally forces Congress to act. But they perform no economic function (collecting, saving, investing, etc.). No money has been salted away in bank vaults. No securities were purchased on Wall Street.

The so-called assets of the Medicare HI Trust Fund, for example, are created on a computer keyboard. They really are IOUs the government writes to itself. But since every “asset” of a trust fund is a “liability” of the Treasury, summing over both parts of government (the Treasury plus the trust fund), assets minus liabilities net out to zero.

Occasionally, people (who are usually disproportionately on the left) will argue that the assets of these trust funds really can be used to pay benefits. Were that true, there would be an easy solution to our financial woes. President Obama, by executive order, could instruct the typists to double, triple or quadruple the number of IOUs the trust funds hold. After all, it is just as easy to hit the 2 key as the 1 key and a 4 is just as easy to punch as a 2. But alas, you cannot increase wealth or purchasing power by writing IOUs to yourself.

So what should we worry about? We should worry about the massive, unfunded liability that is being created for future generations.

The Medicare Trustees tell us that Medicare’s expected future obligations exceeded premiums and dedicated taxes by $89 trillion (measured in current dollars). No, that’s not a misprint. To put that number in perspective, Medicare’s liability is about 5 1/2 times the size of Social Security’s ($18 trillion) and about six times the size of the entire U.S. economy.

Some critics dismiss this estimate because it looks indefinitely into the future. Yet there is a more immediate way to measure the size of the problem, and the results are just as frightening. If we account for Medicare obligations the way private companies and state and local governments have to account for their post-retirement benefits, we would ask this question: If we stopped the Medicare program today, collecting no more taxes and allowing no more accrual of benefits, how much would we owe current workers and retirees for benefits they have already earned? Former Medicare Trustee Thomas Saving and his colleague Andrew Rettenmaier have calculated the answer: $33 trillion!

To paraphrase Everett Dirksen, a trillion here and a trillion there and pretty soon the eyes glaze over. If there is real pain here, when is it going to come, and how are we going to experience it?

Saving and Rettenmaier have answered that question based on assumptions incorporated in the last trustees report. For some time, Social Security and Medicare combined have been paying out more than they are receiving in dedicated taxes and premiums. To cover that deficit, we have been drawing on the general revenues (mainly income taxes) of the federal government. Currently, we are taking more than 1-in-7 income tax dollars for this purpose. By 2020, it will be 1-in-4, and by 2030, 1-in-2.

Basically, elderly entitlements are on a path that will crowd out spending on every other federal program. Throw in Medicaid, and health care spending alone will crowd out every other thing the federal government is doing by mid-century!

Clearly we are on a path that is unsustainable. How can we get off of it?

First and foremost, we must move from a pay-as-you-go system to a funded system. Instead of having each generation of retirees look to the next generation of workers to pay for its benefits, each generation must pay its own way.

Daunting as that task may seem, it is doable. Suppose we ask workers and their employers to put aside 4% of their wages in savings accounts for post-retirement health care. These balances would grow tax free and would replace taxpayer obligations under traditional Medicare. The result: Instead of growing through time, the taxpayer burden for Medicare would eventually shrink to current levels.

Two more changes are needed to radically reform the incentives faced by patients and their doctors. On the demand side, Medicare beneficiaries are currently participating in a use-it-or-lose-it system in which they can realize benefits only by consuming more care. They receive no personal benefit from consuming care prudently, and they bear no personal cost if they are wasteful.

To change those incentives, all new Medicare beneficiaries should be able to manage up to one-third of their health care dollars, using a special type of Health Savings Account (HSA). With these accounts they would be able to keep each dollar of wasteful spending they avoid and bear the full cost of each dollar they waste. Seniors would fund their HSAs with money they currently use for supplemental (Medigap) insurance and out-of-pocket expenses. They would also receive deposits from Medicare itself where it is clear that patients are more appropriate managers of the funds than a third-party-payer bureaucracy.

On the supply side of the market, Medicare providers are trapped in a system in which they are paid predetermined fees for prescribed tasks. They have no financial incentives to improve outcomes, and physicians often receive less take-home pay if they provide low-cost, high-quality care.

To change these incentives, physicians should be free to repackage and reprice their services, thus profiting from innovations that lower costs and raise the quality of care. Any health care provider should be able to propose and obtain a different reimbursement arrangement, provided that (1) the total cost to government does not increase, (2) patient quality of care does not decrease and (3) the provider proposes a method of measuring and assuring that (1) and (2) have been satisfied.

By fundamentally changing incentives, these reforms would dramatically change the disastrous course we are on. Medicare patients would have a direct financial interest in seeking out low-cost, high-quality care. Providers would have a direct financial interest in producing efficient, high-quality care. And worker/savers would have a financial interest in a long-term financing system that promotes efficient, high-quality care for generations to come.

In fact, with these three reforms, the Medicare tax burden would be no greater in 2050 than it is today, as a percent of national income. However, this solution only works if we begin the reform soon. The longer we wait, the more costly and painful reform will be.

Source: National Center for Policy Analysis

John C. Goodman is the president and CEO and a Kellye Wright Fellow at the National Center for Policy Analysis.